Workers in Britain are facing a historic cost-of-living crisis as inflation soars and wages fail to keep up. The Consumer Price Index (CPI) of inflation is at 5.4%, the highest for nearly 30 years, while the Retail Price Index (RPI) which includes housing costs is at 7.5%. Workers and businesses face rising energy bills, housing costs and food prices, tax increases and higher travel costs.
Inflation is calculated as the average change in the price of typical goods and services purchased by UK households over a 12-month period. The latest data has the current CPI at 5.4%. The Bank of England aims to keep the CPI rate of inflation at 2% (plus or minus 1%) and adjusts interest rates to achieve this. The latest Bank of England forecast has inflation peaking at 7.25% in April 2022. Inflation is expected to remain high for the next two years: the Bank expects that inflation will not reach its 2% target until the second quarter of 2024.
As well as higher inflation, household budgets will be squeezed further by changes to taxes and benefits in the coming months. This includes an increase in National Insurance Contributions from April 2022 and changes to income tax. Wages are also forecast to rise more slowly than inflation, which will affect household incomes. Council tax rates will also rise but there will be a freeze on the income tax threshold for the next four years. This usually rises with inflation, allowing people to earn more without being taxed extra. Freezing the personal allowance threshold means that more people on lower incomes will pay income tax. It is estimated by 2025 around 2 million people will be paying income tax who wouldn’t have if the personal allowance rose in line with inflation.
Last week the Chancellor Rishi Sunak delivered his Spring Statement to the nation and announced measures that would assist in helping people to cope with the rise to the cost of living here in the UK. On 3 February, the Chancellor announced government support in relation to rising energy prices, including a £200 energy bills rebate loan, a £150 council tax rebate, and an expansion of the Warm Home Discount scheme. Many people were hoping that the Chancellor would expand further on these promises, especially since they were announced before the Russian invasion of Ukraine and therefore did not take into consideration the new international circumstances that have further exacerbated the financial crisis.
Since the Russian invasion of Ukraine, price rises in many commodities markets has led economic forecasters to raise their expectations for consumer price inflation, not just short-term but also that it will be higher for longer. As well as the obvious military, political and humanitarian impact of Russia’s invasion of Ukraine, there will also be implications for the world’s economy. For the UK, the most likely economic effects will come through higher energy prices and steep rises in the price of oil and gas. Russia and Ukraine are also large producers and exporters of agricultural products such as wheat and some metals. Prices for these products have also risen on financial markets, potentially leading to future increases in food and materials in the UK.
Chris Giles from The Financial Times stated that ‘Chancellor Rishi Sunak can do very little about rising commodity prices. But he can offset the enormous potential losses households face with a windfall tax on those companies that are profiting as a result of the Russia invasion of Ukraine.’
Windfall taxes can be justified when it is reasonable that those drawing up tax legislation did not foresee extreme circumstances that subsequently make them necessary. In 2011, the last time oil prices were high, the then chancellor Dan Osborne imposed a rate of 62% on profits from the North Sea. A broad-based windfall tax that targets Amazon and other large retailers, as well as energy companies, will ensure that all major companies who have made excessive profits during the Covid-19 pandemic and energy crisis can now ‘shoulder the burden’ that millions of families face. The Labour party has suggested increasing the effective corporate tax rate on North Sea activities by 10 percentage points.
Whilst it is still an option to tax some of the larger companies that are benefitting from these crises, the Chancellor has missed an opportunity to offer more help to smaller businesses. Not only are small businesses not subject to the energy price cap, market volatility has made it harder to purchase long-term contracts. The Chancellor does not intend to extend the VAT cut for retail and hospitality, and food prices, especially staples such as wheat, have soared, further putting pressure on the sector. A fuel duty cut will help businesses deal with transportation costs, but the national insurance rise will hit businesses too. This is on top of the debt overhang facing many small and medium-sized enterprises (SMEs) thanks to Covid-19. According to the Bank of England over 25% of SMEs have more debt than cash, and of those a third have debt ten times greater than their cash.
As a result, it may be that much harder to get SMEs to respond to the corporate tax restructuring – encouraging business investment – that the Chancellor proposed earlier this year. Heavily indebted companies will not be able to make the fiscal commitments encouraged by a more benign investment environment, nor deal as effectively with the cashflow squeeze caused by the cost-of-living crisis. The current economic environment has revealed these problems in harsh terms. The UK is vulnerable to external energy supply shocks, we are too reliant on low-skilled services, and our labour market is so tight it is likely contributing to inflationary pressure.
The Chancellor is right to say that Government cannot be the solution to these challenges. The ‘culture of enterprise’ is right to centre the private sector and structural weaknesses that need to be corrected. But in order for those weaknesses to be corrected, rather than obliterated, the Government has to think hard about how businesses will emerge from this cost-of-living crisis.
For an extensive list of changes that were announced in the Spring Statement, follow this link to the government fact sheet.
If you or your SME need help dealing with your financial matters during this difficult time, please do not hesitate to contact us at Islam & Co Chartered Accountants. Our experts are always ready to assist you and can offer advice on the vast majority of financial issues that you or your business may face in the future.
By Katie Cleland – Social Media Administrator